Mutual Fund education
Take the time to familiarize yourself with mutual fund basics before making investment decisions.
Mutual fund basics
A mutual fund is a pool of investments managed by a professional portfolio manager. The portfolio manager invests the money on behalf of a group of investors who have similar investment goals. The fund’s goals are outlined in the fund objectives and how the portfolio manager invests the money to meet the fund’s objective are outlined in the fund’s strategies.
Depending on the fund’s investment objective, a mutual fund can invest in stocks, bonds, cash, or other mutual funds or exchange traded funds. BMO Mutual Funds are further categorized as Security, Income, Growth, Equity Growth, U.S. Dollar Funds and Managed Solutions.
Mutual Funds provide many benefits, including professional money management and diversification with broad investment options across sectors, asset classes and geographies. They are easy to buy and are also available with low minimum initial investment amounts.
Discover the range of Mutual Fund strategies
How investors make money from a mutual fund
Investors in a mutual fund can make money from:
Income distributions – a fund can earn income such as interest and dividends, and from time to time distribute that income to investors.
Capital gains distributions – a fund will realize capital gains when it sells an investment for more than its cost. A fund can also realize a capital loss if it sells an investment for less than its cost. Each year, a fund will distribute its net realized capital gains to investors.
Capital growth – the value of an investment in a fund will rise when the value of the fund’s investments rises, even if the fund has not sold the investments.
If you hold your mutual funds in a registered plan, distributions can only be reinvested in additional securities. If you hold your mutual funds in a nonregistered account, distributions will normally be reinvested in additional securities, but you have the option to request to receive distributions in cash.
Risk Reward Trade-Off
In selecting the mutual funds that best meets your individual needs, you will need to consider the trade-off between risk and returns.
The value of a mutual fund can go up or down. Mutual funds are affected by things like changes in interest rates, economic conditions in Canada or around the world or news about companies the fund invests in. How big the fund’s value changes are is a measure of risk. This is called volatility.
Investments that have the highest return potential fluctuate more with the market in the short term and have a greater possibility of gaining value over the long term.
Diversification is an important investment strategy to help reduce volatility and manage risk.
Building a Financial Plan
The best approach to achieve your specific investment goals is to build a financial plan. Depending on your personal investment knowledge, it may be a good idea to seek advice from an investment professional. An investment professional will help you to build your personalized, tailored plan and monitor it with you on an on-going basis. Some of the things you will need to think about are what you are saving for, how long you plan to stay invested and your risk tolerance.
A plan will help you stay invested and stay focused on your long term goals. See saving for retirement and saving for education for specific investment strategies related to these goals.
Prospectus and Fund Facts
Every mutual fund company must publish and file with the regulators on an annual basis a simplified prospectus and fund facts for each fund and series it offers for sale. The prospectus and fund facts contain a lot of relevant information on the funds you hold.
As a result of recent regulatory changes implemented in 2014, the prospectus is no longer delivered to investors at the point of sale, unless specifically requested by the investor. The fund facts document is now mailed to investors after the sales process is completed.
The most recent versions of these documents are always available on our website in the legal and regulatory section.
Mutual Fund Fees
Every mutual fund company must publish and file with the regulators on an annual basis a simplified prospectus and fund facts for each fund and series it offers for sale. The prospectus and fund facts contain a lot of relevant information on the funds you hold.
As a result of recent regulatory changes implemented in 2014, the prospectus is no longer delivered to investors at the point of sale, unless specifically requested by the investor. The fund facts document is now mailed to investors after the sales process is completed.
The most recent versions of these documents are always available on our website in the legal and regulatory section.
Sales or Redemptions Charges
In addition to the MER, certain series of funds may have sales or redemptions charges. Advisor Series, Series T5, Load Series T6, and Series T8 may also have a sales charge or redemption fee. Each of these series is offered in a front-end, deferred sales charge or low load sales charge option.
You may pay an up-front fee, negotiated between you and your dealer at the time of purchase, if you buy the front-end sales charge option of any of the above series. You will pay a redemption fee if you sell your investment within a certain time period if you buy the deferred or low load sales charge options.
The sales charge or redemption fee depends on the purchase option as follows:
Purchase Options | Sales Charge | Redemption Fees |
|---|---|---|
Front-End(FE) | You pay a negotiated fee to your dealer at the time of purchase of 0 5% for all funds expect for BMO Money Market Fund which is up to 2%. | None |
Deferred Sales Charge (DSC) | None paid by investor. | A declining redemption fee will apply if the investment is redeemed within the first 7 years of purchase. This redemption fee reduces from 6% in the first year to 0% after 7 years. |
Low Load Deferred Sales Charge (LL) | None paid by investor. | A declining redemption fee will apply if the investment is redeemed with the first 3 years of purchase. It reduces from 3% in the first year to 0% after 3 years. |
Mutual fund taxation
Much like any other investment product, whenever you buy and sell a mutual fund there are potential tax implications that should be considered. As investors, we typically spend most of our time trying to ensure that we have the right investments in our portfolio, scrutinizing our decisions based on an investment’s rate of return and risk characteristics. However, it’s not always this simple – and what we earn, isn’t necessarily what we get.
We often don’t think about our investments in the context of taxes, but understanding after-tax returns leads us to becoming better investors, and can be a major influence on whether or not we reach our investment goals.
When it comes to mutual fund investments, taxes that investors are on the hook’ for generally come from 2 different sources:
Taxes on the distributions an investor receives from a mutual fund.
Taxes on a disposition due to selling a mutual fund outright or switching from one mutual fund to another.
Taxes and your mutual funds
In general, you’ll have to pay tax on any money you make on a fund. How much you pay depends on the tax laws where you live and whether or not you hold the fund in a registered plan such as a Registered Retirement Savings Plan or a Tax-Free Savings Account.
If you hold your mutual funds in a registered plan, generally, neither you nor your registered plan is subject to tax on distributions paid by the mutual fund or on capital gains realized when the mutual funds are redeemed or switched. If you hold your mutual funds in a Tax Free Savings Account (TFSA), your investment will grow tax free and you can withdrawal your money tax free.
If you hold your mutual funds in a non-registered account, distributions will be subject to tax whether they are received in cash or reinvested in additional securities. The amount of tax you pay depends on the type of distribution and your marginal tax rate. If your mutual fund increases in value, then you will be required to pay tax on the gain when you sell the fund.
What you need to know about mutual fund distributions
Whether we rely on the income from investments to manage regular day-to-day expenses or if it’s simply because we prefer the benefits of income investing for long-term growth, it’s evident that income investing has become an important part of our portfolios. Depending on your investment goals, there are generally 2 options when a mutual fund makes a distribution:
Receive the distribution in the form of a cash payment
Reinvest the distribution back into the fund by purchasing additional units
A mutual fund can be set up as a trust or a corporation. The main difference between an investment in a trust and a corporation is in how the entity and your investment in the entity are taxed. This is generally more important if you are investing outside of a registered plan.
A mutual fund that is a trust will, each year, distribute enough of its net income and net realized capital gains so that the fund will not be subject to normal income tax. The fund will flow its taxable income through to investors in the form of distributions. Investors are generally taxed on this income as if they earned it directly.
A mutual fund that is a corporation will generally flow its Canadian source dividend income through to investors in the form of ordinary dividends and its net realized capital gains through to investors in the form of capital gains dividends. The fund will pay tax on other types of income (such as interest or foreign source dividends) if that income is more than its deductible expenses and investment losses.
Type of distribution | Description | Tax treatment |
|---|---|---|
Interest | Income that’s earned from investments such as GICs and bonds | Generally treated as ordinary income and taxed at the investor’s marginal tax rate |
Canadian Dividends | Income that’s earned from dividends paid by Canadian companies | The investor can treat the distribution as if it were a dividend from a Canadian company, which may qualify for a lower effective tax rate |
Capital Gains | Realized when an underlying investment within the fund is sold for more than its purchase price | The investor can usually treat the distribution as if it were a capital gain realized by him or her. Half of such a capital gain distribution has to be included in the investor’s income |
Foreign Non-business Income | Income that’s earned from foreign investments, such as shares of U.S. companies | The investor may be able to claim a foreign tax credit for foreign tax paid by the mutual fund |
Return of Capital | When a fund distributes more than its net income and net realized capital gains, which may occur if the fund has a stated fixed distribution amount | Not taxable in the year received, but reduces the adjusted cost base (ACB), which generally results in a larger capital gain (or smaller capital loss) when the investment is sold |
What you need to know about tax consequences when redeeming or switching your mutual fund
The redemption of mutual fund securities is a disposition. If securities are held in your non-registered account, you will generally realize a capital gain or capital loss when you redeem or otherwise dispose of your securities. The capital gain or loss is the difference between the proceeds you receive and the ACB of your redeemed securities, less any cost of disposition.
If you switch your securities of a fund for securities of another series of the same fund, or if you switch between mutual funds within a corporate class structure (i.e., BMO Global Tax Advantage Funds), the switch is made either as a redesignation or a conversion of your securities, depending on the situation. In other words, the switch should occur on a tax-deferred basis so that you do not realize a capital gain or capital loss on your switched securities. Any other type of switch involves the redemption of your securities, which is a disposition for income tax purposes.
Capital gains must be reported for tax purposes in the same year they are realized. Because only 50% of the gain is taxable, capital gains are taxed more favorably than other types of income. Most capital losses can be used to offset capital gains to reduce an investor’s tax liability. If, however, an investor does not have any realized capital gains in the same year that a capital loss is realized, the loss can be carried back and applied against realized capital gains from any of the previous 3 years. Investors are also allowed to carry the loss forward indefinitely to offset gains in future years.
Depending on your investment goals, it may make sense to consider investment strategies within your portfolio that are tax efficient. Speak to your advisor or tax specialist to get details on tax-efficient strategies for your portfolio.